Weekly market commentary | BlackRock Investment Institute

A transformation of a historic scale could be unfolding. Investment opportunities transcend the unusual macro backdrop of sticky inflation, higher interest rates, slower growth and elevated debt. U.S. equities had a banner first half of 2024 versus other developed markets (DMs) even as markets priced out Federal Reserve rate cuts. The strength of U.S. stock gains has been matched by corporate earnings beating expectations, led by a handful of AI names. See the chart. As a result, we see concentration as a feature, not a flaw, of today’s market environment. We expect some volatility ahead as markets grapple with a wide range of outcomes – as shown by last week’s brief retreat in tech shares. Recent low market volatility doesn’t reflect all risks ahead, in our view. We still think the next six to 12 months is a time to lean into risk but we prepare to reassess as new opportunities arise.

In the near term, we see a concentrated group of AI winners driving returns. We stay overweight U.S. stocks and the AI theme. AI-related data center investment could rise by 60-100% annually in coming years, according to a mix of forecasters including the International Energy Agency. We see the AI theme playing out in three phases. This first AI buildout phase is already producing early winners – including big tech firms, chip producers and companies supplying key inputs like energy, utilities, materials and real estate. Yet this phase faces challenges, such as whether the power grid can keep pace. We think markets and central banks underappreciate the inflationary impact of this early phase. The next phase could see investment broadening to companies looking to harness AI’s power. The final phase – potential economy-wide AI productivity gains – is highly uncertain. These gains can only come after AI capabilities are fully deployed, a process that could take many years.

Going overweight UK equities

We also lean into risk by going overweight UK equities. We see the Labour Party’s landslide UK election victory increasing the likelihood of a two-term government. The potential for long-term policy implementation should bring relative political stability, in our view. We think perceived stability can help improve sentiment – especially among foreign investors who own more than half of UK shares. We added to our overweight to Japan equities in March due to corporate reforms. Wage gains are filtering into mild inflation and corporate pricing power, reinforcing our optimism on a long-term strategic horizon.

We balance our risk-on view by staying selective in fixed income, focusing on quality. We prefer short-term government bonds and credit that are delivering much higher income than pre-pandemic. We are overweight short-term investment grade credit given signs that lower-quality pockets are starting to show cracks from higher-for-longer rates. Strategically, we like private credit over public. Private credit defaults remain relatively limited. Private markets are complex, with high risk and volatility, and not suitable for all investors. By region, we like long-dated UK gilts over long-dated U.S. Treasuries strategically.

Bottom line

We see unprecedented transformation unfolding in the real economy. We lean into risk as a result. In stocks, we like the U.S., UK and Japan. We prefer quality income in fixed income – especially in short-term credit – and like private credit.